How Inflation can be Beneficial for Property Investors?

The topic of inflation has recently consumed headlines across the globe, causing panic about the cost of living and the general economic landscape of the current times. 

But inflation isn’t always a bad thing, and there’s a specific group of people that stand to benefit from rising prices - property investors. 

Inflation has the potential to create an environment conducive to greater returns for property investors, for a multitude of reasons, and it can also act as a ‘hedge’ against it.

To fully understand how inflation might be of benefit to investors, it’s important to first understand what inflation actually is.

What is inflation?

According to the Reserve Bank of Australia (RBA), inflation is ‘an increase in the level of prices of the goods and services that households buy’.

The most widely known measure of inflation is the Consumer Price Index (CPI), according to the RBA, which is calculated by the Australian Bureau of Statistics (ABS) by tracking the prices of a range of goods and services, grouped into categories.

Inflation generally indicates a growing economy, but as we’ve seen in recent years, inflation that outpaces wage growth can present problems in the wider economy. 

For this reason, the RBA has a preferred range of 2-3 per cent that they try to maintain with tools like monetary policy, evident in the most recent round of cash rate hikes. 

They deem this to be the ‘sweet spot’, where the economy is growing, but in the RBA’s own words ‘is a rate of inflation sufficiently low that it does not materially distort economic decisions in the community’.

So how does inflation create greater returns for property investors?

Interest rate rises are squeezing the budgets of most mortgage holders on variable rates across the country, as the RBA hikes the cash rate to bring inflation back to its target. 

But mortgaged investment properties can actually gain from rising prices (inflation), as rents tend to follow suit, cushioning the added costs of higher interest rates. And while the cash rate is likely to come back down in the near future, rents probably won’t.

In some cases, rents rise even faster than inflation, as seen in the past year when house rents rose a whopping 16 per cent in Sydney, according to AFR, far outpacing inflation. 

But rising rents aren’t the only way investors could be profiting. There’s also the ‘hedge’ effect that property can have against inflation.

The ‘hedge’ effect

The effect inflation has on money means that your current dollar will buy less in the future. 

Rising costs mean that the value of money depreciates over time as the economy grows, essentially eroding the value of savings if they’re sitting stagnant in a bank account.

Assets with a set annual return are also vulnerable to value erosion, as the real value of returns depreciates over time.

But one way to combat this is to invest in assets that have a steady track record of value accumulation, with returns that increase with inflation - like property.

According to CoreLogic, property rose 382 per cent over the 30 years to 2022, while prices (inflation) rose by 99.5 per cent. Rents also rose exponentially during this time.

Over the past 30 years, the strongest growth was recorded during the decade of 1992-2002, clocking 77 per cent growth on the national Home Value Index (HVI). 

This was followed by the most recent decade (2012-2022), which saw home prices grow by 72 per cent. The middle decade (2002-2012) saw home values increase by a slightly softer but still impressive 59 per cent.

Investing savings into an asset class backed with promising historical data, like property, means it appreciates at a rate likely to be higher than inflation.

The other benefit is that if a property is mortgaged, the money borrowed from the bank at the time of purchase will be worth less in the future, so essentially, you are paying back a loan with money worth less than it was when the purchase was initially made.

Additionally, the loan-to-value ratio will also improve, as the value of the property grows and creates equity.

Is property investment an effective strategy against inflation?

Property has long been touted as an effective ‘hedge’ against inflation, but the proof is in the pudding. Investors who use property as a long-term strategy stand to benefit from capital growth and rental returns simultaneously. 

An investor who purchased a Sydney house just ten years ago, at $722,000, will have made almost $700,000 as the median house price now sits just shy of $1.4 million. That’s without considering their profits from rental income.

Alternatively, if they’d left the money required for a house deposit in a high-interest account, paying 5.5%, they’d have earned just $102,000 over that same ten-year period, according to ING’s savings calculator.

With inflationary pressures pushing up the cost of living, that $100,000 profit is now limited in what it can buy, and pales in comparison to the equity in an investment property.

While inflation means initial home ownership costs are heightened, due to higher interest rates and high property prices, it also means that your money is somewhat immune to inflationary erosion. Instead of sitting stagnant and eventually buying you less, it will accumulate in value as property prices rise.